Featuring Lutts’ Logic:
10 Favorite Low-Priced Stocks Follow-Up
Money Goes Where it’s Treated Best
A High-Potential Chinese Stock
Late last year we published a Special Report titled, “Cabot’s 10 Favorite Low-Priced Stocks for 2009,” writing, “buying a few of these more speculative names in mid- to late-December, and holding from two to 10 weeks, can produce outsize gains.”
Well, it’s been more than eight weeks since most readers received their reports, and because I recently received an inquiry for follow-up from a subscriber, I thought I’d provide it to everybody.
Note: Investing in low-priced stocks is tempting but tricky. Our advice said, take small positions, cut all losses short, and take profits on the way up. With those guidelines in mind, here’s how an average reader might have fared.
Three of the stocks brought good profits, with no possibility of loss.
Compellent Technologies (CML), which might have been bought around 9.30, is now at 13.78, up 48%. It can be bought on pullbacks.
Optimer Pharmaceuticals (OPTR), which might have been bought at 8.50, hit 12.43 at year-end, and is now at 11.40 building a base. If you bought in mid-December, you should have taken some profits, but the stock looks good and can be bought here.
Zhongpin (HOGS), which might have been bought at 10.50, peaked at 12.55 at year-end, but then faltered and is now at 10.09. Some profits should have been taken. (The stock’s action is not impressive, but the excellent fundamentals mean it’s still on the Watch List of Paul Goodwin, editor of Cabot China & Emerging Markets Report.)
Four of the stocks did very well, and could have provided you with some profit if handled carefully.
Harmony Gold (HMY), which might have been bought at 9.5, is now at 12.02, but brief dips below 9 might have knocked you out with a small loss.
Orion Marine (OMGI), which might have been bought at 8, peaked at 10.26, pulled back to 8.16, and is now at 9.73, looking healthy.
Fuqi International (FUQI), which might have been bought at 6.70, peaked at 7.89 but is now down to 4.77 and looking bad.
Vaalco Energy (EGY), which might have been bought at 6.50, quickly fell to 5.50 but then zoomed to 8.47! It’s now at 8.11 and looking good.
And three stocks did poorly.
Airtran (AAI), which might have been bought at 4.75, hasn’t done much and is now at 4.3, looking a bit anemic.
99 Cents Only Stores (NDN), which might have been bought at 11.00, bottomed at 6.86 and is now at 7.81, still looking unhealthy.
Silicon Image (SILC), which might have been bought at 5.00, bottomed at 2.57 and has bounced up to 3.49, but we’re not impressed.
Overall, my analysis says an average investor who bought all 10 stocks and followed the instructions above, cutting losses short at 15%, might have earned an average profit of 13%, not bad at all for two months at the bottom of a bear market. No doubt some readers did better and some did worse. If you’re among the former, congratulations. If you’re among the latter, I suggest you take the time to review your actions, and determine whether you simply chose the wrong stocks or chose the right stocks but bought and sold at the wrong time. The goal of such analysis, of course, is to become a better investor.
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I recently received the following email from a subscriber in Georgia.
“I appreciate your musings several times each week. Yesterday’s, with its reference to your parents’ anniversary, reminded me of a Cabot Market Letter many years ago in which your father wrote about the relative size of the bond market and stock market and, if I recall correctly, said that the bond market was quite a bit larger than the stock market. In those days he used interest rates to predict whether money would have a tendency to flow from bonds towards equities or from equities towards bonds. There was a chart each issue showing this tendency. There was a maxim: “Money goes where it’s treated best” which summarized this tendency. Anyhow, my question today is: Where is all the money? I understand that there are trillions “on the sidelines.” Is it in bonds, in money market accounts, in Swiss banks, in China? Has it “disappeared?” A bull market won’t get started until this money begins flowing towards equities and I, and probably others, would appreciate your take on where it has to come from. Again, I really appreciate you and all of the other Cabot editors who correspond with us.”
I answered his questions promptly but today I want to elaborate.
First, back in 1970s and 1980s, we had a market timing tool called the Power Index, which tracked the trends of interest rates. Back then, when interest rates were high, they were an important lever of the Federal Reserve’s fiscal policy. To slow the economy, the Fed would raise rates. To accelerate it, they’d reduce rates. And the Power Index, which was found on page 4 of every issue of Cabot Market Letter back then (along with our other market timing indicators), was a great indicator that helped us determine when rates had moved enough to force a change in the market’s trend.
Occasionally, when the Power Index told us we’d reached a major market bottom, and the Fed was busily lowering interest rates, we’d also print a graphic on page 1 illustrating the relative size of the stock and bond markets, in effect showing subscribers that the bond market was so much larger than the stock market that even pulling perhaps 5% of the money out of the bond market would cause a huge jump in stocks.
Back then, the phrase we used was “Money goes where it’s treated best.” I don’t claim that my father coined it, but I do know that he adopted it and he fed it well over more than two decades.
Then came the runaway bull market of the 1990s, fueled–as we know now–by loose credit and growing perceptions that the Internet would change everything.
In this new environment, rising interest rates lost their power to slow the economy, and in the bear market after the 2000 top, falling rates failed to stop the plunge; the Power Index stopped working, and we eventually dropped it. For market timing Cabot Market Letter now uses two trend-following indicators and one that looks at the internal health of the market.
But the principle behind the aphorism remains. Money goes where it’s treated best, or at least where investors perceive it will be treated best.
Today, as G. B. has noted, a lot of money is on the sidelines somewhere, because fear is high. It’s in money market accounts paying 0.5%. It’s in three-month T-bills yielding 0.3%. And it’s in 30-year government bonds paying 3.5%, which is better than losing money, but will look pretty meager after the next bull market begins.
Finally, a lot of the money has “disappeared,” as prices of both stocks and (mainly corporate) bonds fell in the past year. As prices recover, that money will “reappear,” but in different places, where investors perceive it will be treated best.
Bank of America and Citigroup, for example, will not see much recovery. But young companies that have not yet been fully loved by investors will soar. You can read about them here regularly.
But it won’t be falling interest rates that will kick off the buying. It will be a fading sense of fear, and a growing sense of optimism that the profit opportunities in specific areas are too big to pass up. That’s why we rely on our trend-following indicators today; they’ll alert us to when that fear has indeed faded, whereas interest rates will not.
So, taking off from the concept that the next big winners will be companies that were previously unknown and unloved, here’s today’s investment idea.
It’s China Sky One Medical, a developer of over-the-counter nutritional supplements and traditional Chinese remedies and medicines. In 2005, revenues were $7.7 million, in 2006, they hit $20 million, and in 2008 they swelled to $49 million! In the most recent quarter, revenues grew 77% to $29.7 million, while earnings grew 36% to $0.60 per share.
Here’s what editor Paul Goodwin wrote in Cabot China & Emerging Markets Report back on December 11.
“China Sky One Medical (CSKI) has grown its sales 158% and 148% in the last two years with a huge product line that includes items like weight-loss patches, wart removers, hemorrhoid ointments and dandruff shampoos. A quarter of the company’s sales come from outside China, which is a good connection for any Chinese retailer.
“CSKI has been public just since May, and it has been through a decline from its post-IPO high of 17 to an October low of 6, before recovering strongly on good volume to 13. The stock’s average trading volume is just 53,000 shares a day, which is way too low to ensure liquidity. But with a P/E of 8 and strong sales and earnings numbers (including an after-tax profit margin of 33.5%), along with a strong chart, it’s one to keep an eye on. Which is exactly what we’ll do. WATCH.”
Since then, trading volume has grown, and now averages 115,000 shares a day-still light, but moving in the right direction. And the stock’s action is encouraging.
Last week, in fact, Paul wrote, “The chart for CSKI shows a stock that is trading sideways in a tight range between 14 and 15. This is exactly the kind of launching pad we like to see, as a tightening chart on declining volume often precedes a big move. The stock made just such a move after spending seven days above resistance at 12 in late January. Continue to watch CSKI.”
Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory
Editor’s Note: Cabot China & Emerging Markets Report was the #1 newsletter for 2006 and 2007 with gains of 78.6% and 74.1% respectively, according to Hulbert Financial Digest. The Report remained the top-rated newsletter throughout much of 2008, despite the market’s crash. Editor Paul Goodwin applies Cabot’s time-tested growth stock investing system to the emerging markets to tell you when it’s time to buy and when it’s not. Right now, Paul is discovering the top stocks in the emerging markets, many of which will likely lead the new bull market higher. Don’t let the opportunities in the emerging markets pass you by, click the link below to get started today.